Private equity firm Compass Diversified Holdings has announced a strategic review that could lead to the sale of some of its businesses. This move is aimed at reducing its significant debt burden, a situation exacerbated by the need to restate several years of financial results. The restatements are necessary due to alleged accounting fraud discovered at its luxury jewelry subsidiary, Lugano Diamonds & Jewelry Inc.
Debt Crisis and Covenant Breach
During a conference call on Thursday, Compass CEO Elias Sabo stated that reducing debt is the company's top priority. This urgency stems from the firm being out of compliance with leverage ratio covenants tied to its credit facility. Sabo described the current situation as "the most challenging period" in the company's history.
To address this immediate pressure, Compass officials confirmed they are in active discussions with senior lenders. The goal is to secure an amendment to the existing credit agreement, which would provide the company with more flexibility regarding its current debt levels. This development follows a Bloomberg News report from August, which revealed that a group of Compass bondholders had sought advice from the prominent law firm Kirkland & Ellis.
The Lugano Diamonds Scandal and Financial Fallout
The root of the current crisis traces back to May, when Compass disclosed it had discovered serious irregularities at Lugano Diamonds. The subsequent investigation has forced the firm to prepare restated financial statements for the years 2022 through 2024.
The situation at Lugano escalated last month when the jewelry subsidiary itself filed for Chapter 11 bankruptcy protection. In its filing, Lugano accused its founder of inflating revenue by misrepresenting diamond investment contracts made with clients. Compass has assured stakeholders that the alleged fraud was confined to the Lugano business and did not impact its other subsidiaries.
Path Forward: Asset Sales and Future Compliance
Compass CFO Stephen Keller provided a timeline for recovery, indicating the firm anticipates being able to comply with its leverage covenant by 2026. However, to accelerate the debt reduction process, the company is proactively exploring the divestment of one or more of its subsidiaries.
Beyond Lugano Diamonds, Compass Diversified's portfolio includes other well-known brands. These include The Honey Pot Company, a feminine care business, and Arnold Magnetic Technologies. The sale of any of these assets could generate crucial capital to shore up the firm's balance sheet.
The coming months will be critical for Compass as it navigates dual challenges: managing the legal and financial aftermath of the Lugano scandal while simultaneously negotiating with lenders and potential buyers to stabilize its overall corporate structure.
